Public pension reforms often fall short of what is needed

The term pension reform has come to include a long list of possible courses of action by state and local governments. These pension reforms could include adding benefit tiers, changing contribution rates, modifying cost-of-living adjustments, adding alternative retirement plan options, and many others. All are pension reforms in the strict sense and are often needed to meet certain policy objectives of legislators, plan administrators, employee representatives, and other influencers.

While all these changes fall under what is commonly considered pension reform, there is a crucial distinction between fixes to specific public pension problems and reforming a pension plan to better meet its core objectives. Understanding the difference between these actions is vital for policymakers undertaking pension reforms because, in most cases, a combination of both is needed.

Frequently, public pension reforms aim to improve the funding status of the traditional defined benefit plans still in use by most state and local governments. Many legacy defined benefit (DB) pension plans have been significantly underfunded due to years of market returns coming in well below the plans’ previous investment return expectations and a general slowness to act on new emerging costs. These shortfalls in funding for promised pension benefits can total millions and even billions of dollars. 

State and local governments, in many cases, have made various contribution-related changes to these plans to manage their budgets better and head off impending financial and benefit-related crises. While pension funding changes that improve the financial picture of a traditional DB plan are necessary reforms and should be applauded, they should be considered a partial reform effort. 

Funding reform may address one aspect of a broader issue, but it is only part of it. Any reform effort that tackles a single element relating to a retirement plan is not full pension reform because it has yet to ask the fundamental question: Is the current pension plan design working? Have circumstances changed to reconsider the design of the plan going forward?

With these questions in mind, any broad or full public pension reform effort should start by restating or redefining the objectives of the retirement plan itself. Once this task is done, the objectives should be measured against the design and performance of the existing plan. 

This process should paint a picture of the direction in which any needed pension reforms should go. The results could vary widely by plan, ranging from funding reform to a complete retirement plan redesign for newly hired employees. 

Rarely, if ever, especially for an initial pension reform effort, will only one type of needed change be identified. Public retirement plans are large and complex and, in most cases, have existed for decades. Along the way, the original goals of the plan have been clouded by political exigencies and short-term needs.

To foster a comprehensive pension reform effort, policymakers often must restate a retirement plan’s core objectives. Along with clearly stated goals, reform leaders must commit to addressing all necessary changes. Policymakers do not need to apply all necessary changes at the same time, but they should plan for and sequence reforms in the most efficient manner. The most important thing for leadership to accomplish is to address all issues identified by establishing the objectives of the retirement plan. Failure to apply this comprehensive approach leaves the door open for past problems to reemerge.

This issue often arises with funding reform. Policymakers will observe the growth of crippling unfunded liabilities impacting the pension plan and broader budgets and make changes that bring projected funding levels up to what is perceived to be manageable levels. These changes might include contribution increases by employers and employees and possibly even large capital infusions of assets into the plans. These actions could immediately improve the plan’s funding level and bring it out of crisis and into solvency. 

It is possible, however, that without further structural changes, the pension plan could slip back into an underfunded state for the same reasons it did initially. Often, issues with unrealistic actuarial assumptions, unpredictable costs, and unsustainable plan designs will bring a retirement plan right back to the funding crisis that policymakers assumed was already addressed in previous pension reforms. In many cases, policymakers fall into the trap of addressing only contributions, often merely buying them time before they must address larger concerns.

In this way, funding reform may be confused with overall pension reform in the public sector. In these cases, the most significant gap in the process is thoroughly examining how the pension plan realistically benefits employees and employers. Policymakers have failed if a traditional pension is brought up to a satisfactory funding level but still does not benefit most participants. This failure may not be immediately observable, but over time, it will become clear that a great deal of money and effort was spent to have a solvent pension plan that still does not meet the retirement security needs of many public workers, the plan’s most important objective.

Traditional public sector defined benefit plans were designed long ago to provide lifetime income to long-service employees. At one time, many, if not most, employees in these positions stayed with the same employer for 20 or 30 years or more. At the end of their careers, they retired with a benefit from the employer-sponsored pension plan that, when combined with Social Security (if applicable) and personal savings, provided an income in retirement that allowed them to maintain their accustomed standard of living.

For better or worse, the employment pattern in the public sector looks much like that in the private sector today (and has for more than a generation). Median employment tenure is around six years, with most workers having an increasing number of different employers throughout their careers, both in and out of the public sector. 

Actuarial data from the public DB systems consistently show that only about one-third of newly hired employees will qualify for a lifetime income pension benefit. A pension plan that does not meet basic employee needs cannot meet employer needs for recruiting and retaining qualified workers. With a retirement plan that recognizes the reality of the mobility of today’s workers and meets their needs, the needs of employers can also be met.

Funding reform without structural reform that recognizes the reality of modern employment patterns will often prove inadequate. To succeed over the long term, pension reform efforts need to include fixes for existing problems and accurately anticipate the future needs of a plan’s beneficiaries. To do one without the other is a fool’s errand.

Solutions that meet the needs of workers and employers today do exist. Many such retirement plan design examples are in use. These are not high-risk designs that imitate past efforts in the corporate sector. Rather, like the Pension Integrity Project’s Personal Retirement Optimization Plan, they are income-focused and risk-averse and include cost-appropriate designs focused on maximizing public employee and employer outcomes.

Policymakers need to look beyond politics and focus on true public pension reforms. This process must include examining whether the pension plan’s design must change to match the needs of current and future workers. It may entail implementing several reforms and certainly will take hard work. As the cliche goes, few things worthwhile are ever easy. Public pension reform is no different.